There are plenty of obvious benefits of being self-employed, including being your own boss and the freedom to choose your own schedule. But applying for a mortgage hasn’t always been one of them.
Being a self-employed mortgage applicant means you’ll be subject to different lending criteria compared to someone who’s on payroll. Recently, the rules governing how self-employed individuals have been updated. It’s important to understand what these rules are, and how they’ll impact your ability to get approved for a mortgage if you work for yourself.
Getting Approved For a Home Loan When You’re Self-Employed
Lenders will obviously want to make sure that you’re financially capable of carrying a mortgage and making payments in full and on time each month. That’s why they’ll ask to see specific documents to prove this, including documents showing your income and assets which determine how much you can afford to pay and where your down payment will be coming from.
Since you are not on a payroll, you won’t be able to produce an income statement such as a paycheck like the average salaried employee can show.
When it comes to your income as a self-employed borrower, you’ll need to depend on the self-employed income you claimed on IRS Schedule C, which keeps tabs of your income and expenses. You’ll be responsible for coming up with a lot more documentation to prove to your lender that you’re fully capable of affording a mortgage and making payment in full and on time each month. This can become quite cumbersome, especially if the documentation you’ve been keeping is scarce.
If your business is conducted as a corporation, partnership, or LLC, and you own at least 25 percent, separate sets of tax returns will need to be filed. You’ll need to give your lender these business tax returns along with your personal ones.
As far as assets are concerned, you might have a lot of your money tied up in your business, and may want to put these funds towards a down payment. Some lenders might allow this, others may not. If your lender lets you use business assets to put towards a down payment, your bookkeeper or accountant (or whoever does your taxes) will have to verify that using these business funds to purchase a home won’t have a negative effect on the health of your business.
New Guidelines For Self-Employed Borrowers
As of this past February, the income calculation rules for self-employed borrowers who own partnerships and S corporations have been tightened by Fannie Mae. The new guidelines involve a more stringent analysis of a company’s income and debt to pinpoint if there are adequate assets to use towards the home purchase, as well as to continue paying all of the company’s owners.
If you run a business like these, you should expect your income to be shown on a Schedule K-1 form, which makes up a part of your company’s tax filing. The numbers on this form are declared as income on your personal tax return. Your income will come in two forms, including your ordinary business income and distributions.
The new rules for self-employed borrowers place regulations on whether or not you’re able to use any one of these forms of income. If your company’s distributions are greater than your ordinary business income, for instance, then your ordinary business income can be used for mortgage qualification purposes.
While the new rules may have tightened certain aspects of mortgage approvals for the self-employed, they’ve also loosened others. Overall, the new Fannie Mae mortgage guidelines should reduce the total amount of documentation that will need to be produced. The following policy updates have been in effect since late-August 2015, and cover three main areas:
1. Self-employed borrowers with irregular or non-existent business distributions. In this case, if you don’t necessarily have a history of paying yourself through dividends of the business, you’ll only be required to show that you have access to your business income by producing the K-1 filing or a letter of incorporation. You’ll also have to show that your business has adequate liquidity.
2. Self-employed borrowers without two years of federal tax returns. The new rules are more lax when it comes to businesses who don’t have two years of tax returns to support the business. In this case, all that’s required is proof of one year of federal tax returns, as long as your company’s cash flow shows at least 12 months of reliable self-employment income, and a sound cash flow analysis of the business.
3. Salaried borrowers who also have a second self-employment job for which the income isn’t required to qualify. Any income from a second self-employed business or job doesn’t have to be shown to qualify for a mortgage under these new rules. This is good news for those who depend on pension payments, social security income, retirement income, or dividends as forms of payment. If your mortgage application proves sufficient household income without self-employment income, you won’t have to show federal income or corporate tax returns in relation to self-employment.
These new rules set forth by Fannie Mae make it easier and more streamlined for self-employed borrowers looking to secure a mortgage. Coupled with low mortgage interest rates these days, now may be an excellent time to consider your mortgage options and start seeking out homeonwership.
